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1992

The Entertainment Facility Rules Of Section 274and Corporate-Owned CondominiumsMary E. Vandenack

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Recommended CitationVandenack, Mary E. (1992) "The Entertainment Facility Rules Of Section 274 and Corporate-OwnedCondominiums," Akron Tax Journal: Vol. 9 , Article 6.Available at: https://ideaexchange.uakron.edu/akrontaxjournal/vol9/iss1/6

THE ENTERTAINMENT FACILITY RULES OF SECTION 274 ANDCORPORATE-OWNED CONDOMINIUMS

by

MARY E. VANDENACK*

INTRODUCTION

In the past decade Congress has focused a lot of attention on limiting oreliminating deductions for lavish entertainment. An area where deductions havebeen virtually eliminated is that of "entertainment facilities." This Article examinesthe disallowance provisions of I.R.C. § 2741 concerning entertainment facilities inthe context of corporate-owned entertainment facilities.

To aid the discussion of § 274, this Article focuses on a hypothetical set offacts. Corporation owns two condominiums. One condominium is located in aColorado resort area and is affectionately called Tummyache. The other condo islocated in a resort area in Florida and is affectionately called Four Clovers.

Tummyache is used by customers, prospective customers, and employeesof Corporation, and sometimes by individuals unrelated to Corporation. The policyof Corporation is to treat use of the condo by employees as compensation. Thevalue of such use is treated as a taxable fringe benefit to the employee and includedas compensation on the employee's W-2. The usage of the condo is about fortypercent by employees and sixty percent by customers and others.

Four Clovers is used only by one of Corporation's stockholders, Emma.Emma stays at Four Clovers for about four months each winter and rents thecondo during that time. Four Clovers is not available to employees or customers.Four Clovers is not held out for rent when Emma is not staying there.

ENTERTAINMENT FACILITY RULES

In General

Section 162 of the Internal Revenue Code allows "a deduction for allordinary and necessary expenses paid or incurred during the taxable year incarrying on any trade or business."2 Section 274 is a disallowance provision.3 Even

* The author is presently associated with Joe Vandenack & Associates P.C., a law firm emphasizing

tax practice, in Yutan, Nebraska. She received a B.S. 1990, College of St. Mary, Nebraska, summa cumlaude; J.D. 1992, Creighton University School of Law, magna cum laude. The author is a member ofSCRIBES-the American Society of Writers on Legal Subjects.

1 I.R.C. § 274(a) (1992).2 I.R.C. § 162 (1992).

3 See I.R.C. § 274(a) (1992).

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if a taxpayer demonstrates that an expense is allowable under § 162, the expensemay be disallowed by operation of § 274 or another disallowance provision.

Section 274 relates specifically to entertainment expenses. Section 274(a)operates to disallow deductions in connection with an entertainment facility.Section 274(a)(1)(B) provides in pertinent part:

(a) ENTERTAINMENT, AMUSEMENT, ORRECREATION. -

(1) IN GENERAL. - No deduction otherwise allowableunder this chapter shall be allowed for any item -

(B) FACILITY. - With respect to a facility used inconnection with an activity referred to in subparagraph (A).4

The activity referred to in subparagraph (a) is "an activity which is of a typegenerally considered to constitute entertainment amusement, or recreation." 5 Thus,§ 274(a)(1)(B) operates to disallow expenses with respect to an "entertainmentfacility."

What Is A Facility?

The term "facility" is not statutorily defined. However, the legislative historyindicates that the term "facility" includes "any item of real or personal propertywhich is owned, rented, or used by a taxpayer in conjunction or connection with anentertainment activity." 6 Vacation homes and cabins or other buildings in resortareas have been held to be facilities for purposes of § 274. 7 However, otherwisequalifying business expenses relating to a "facility" are not affected unless the"facility" is used "in connection with entertainment."

What Is Entertainment?

"Entertainment" is defined in the regulations as "any activity which is of atype generally considered to constitute entertainment, amusement, or recreation." 8

The regulations provide for an objective test under which the issue is whether theactivity is of a type that would generally be considered entertainment. 9

4 I.R.C. § 274(a)(1)(B) (1992).' I.R.C. § 274(a)(1)(A) (1991).6 H.R. CoNF. REp.No. 1800, 95th Cong., 2d Sess. (1978); 1978-3 C.B. 521, 583-84 (1978); S. REP.

No. 1263, 95th Cong., 2d Sess. (1978); 1978-3 C.B. 315, 472-73; Treas. Reg. § 1.274-2(e)(2) (as amendedin 1985).

1 See Ireland v. Commissioner, 89 T.C. 978 (1987); McReavy v. Commissioner, 57 T.C.M. (CCH)133 1989).

Treas. Reg. § 1.274-2(b)(1)(i) (as amended in 1985).9 Id

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What Is Meant By "In Connection With"?

Section 274(a)(1)(B) disallows all expenses with respect to a facility if thefacility is used to any extent at all for entertainment.' 0 That is, § 274(a)(1)(B), asamended, operates as an absolute bar to the deductibility of expenses with respectto a facility, if any. use of the facility, no matter how small, involvesentertainment. 11

Section 274(a)(1)(B) was amended in 1978.12 Prior to that amendment, §274(a)(1)(B) disallowed expenses with respect to an entertainment facility unlessthe taxpayer could establish that the primary use of the facility was in furtheranceof the taxpayer's trade or business. " The "unless" portion of the statute was deletedin the 1978 amendment.' 4 As a consequence of this deletion, the primary use ofthe facility is no longer relevant. 15

Section 1.274-2(e)(2)(ii) of the Income Tax Regulations contains an"incidental use" exception. 16 After § 274(a)(1)(B) was amended in 1978, theRegulation was also amended. 17 The heading to § 1.274-2(e) now reads"Expenditures paid or incurred before January 1, 1979, with respect toentertainment facilities or at any time with respect to clubs." 18 This amendmentindicates that the "incidental use" exception applies only to expenditures paid orincurred prior to January 1, 1979.9

I.R.C. § 274(a)(1)(A) disallows entertainment expenses unless a taxpayerestablishes that the item is "directly related to" or in some cases "associated with"the taxpayer's business. 3D The "directly related to" and "associated with" exceptionsof § 274(a)(1)(A) do not apply to § 274(a)(1)(B) with respect to entertainmentfacilities. 21

Are The Corporation Condominiums "Entertainment Facilities"?

Both of the Corporation condominiums can be classified as entertainmentfacilities. One of the examples of an entertainment facility given in the regulations

'0 Ireland, 89 T.C. at 983.

" Id. See also Security Assocs. Agency Ins. Co. v. Commissioner, 53 T.C.M. (CCH) 1239 (1987).12 Ireland, 89 T.C. at 981.13 Id14 id

/

15 id

16 Treas. Reg. § 1.274-2(e)(2)(ii) (as amended in 1985).17 Robert Zbacnik & Jim Ellerbeck, "Entertainment Facility" Takes on a New Meaning, 19 TAX

ADVISER 852, 852 (Dec. 1988).18 See Treas. Reg. § 1.274-2(e) (as amended in 1985).'9 Ireland, 89 T.C. at 984.20 See I.R.C. § 274(a)(1)(A) (1992).21 See Stan Frisbie, Inc. v. Commissioner, 60 T.C.M. (CCH) 440 (1990).

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is a vacation home in a resort area. Because both condominiums are in vacationareas and are used for activities that are generally considered to be recreation orentertainment, both condos would fall within the definition of "entertainmentfacilities."

What Deductions Are Disallowed?

Section 274 disallows expenses in connection with an entertainment facility,whether or not those expenses are true business expenses. 3 If the facility is usedfor entertainment, then all deductions with respect to the facility are foreclosed.Disallowed deductions include maintenance expenses, operating expenses,depreciation, and loss on the sale of the facility. Is

Nevertheless, the rule barring deductibility of expenses for entertainmentfacilities does not apply to certain expenditures. For example, out-of-pocketexpenses incurred contemporaneously with an entertainment activity are notsubject to the rule that generally disallows facility-related expenditures (e.g. foodconsumed at a meeting).26 The rule also does not apply to expenses that areallowed without regard to the connection of the expenses to the taxpayer's trade orbusiness, such as taxes, interest, and casualty losses. -7

What Happens If Expenses Are Disallowed?

The statute provides that if expenses are disallowed "with respect to anyportion of a facility, such portion shall be treated as an asset used for personal,living, and family purposes and not an asset used in the trade or business." 2 If acorporate-owned vacation condominium is found to be an entertainment facility,then the condominium will be treated the same for tax purposes as a personalresidence.29 "If deductions are disallowed under [§ 1.274-2] with respect to anyportion of a facility, then such portion shall be treated as an asset which is used forpersonal, living, and family purposes." 30 The "basis of such a facility will beadjusted for purposes of computing depreciation deductions and determining gain

22 Treas. Reg. § 1.274-2(e)(2)(i) (as amended in 1985).23 See Security Assocs. Agency Ins. Corp. v. Commissioner, 53 T.C.M. (CCH) 1239 (1987).24 ld

25 See Charles E. Federanich, Travel and Entertainment Rules From a Practice Development Point of

View, TAX PRACTICE MANAGEMENT, Mar. 1992, p. 188-189.26 In Dodd v. Commissioner, 63 T.C.M. (CCH) 3141 (1992), the court found that expenditures for

beer, champagne, and snacks provided on a hot air balloon ride were deductible under § 162 (subject tothe eighty percent entertainment limitation) as business expenses that were incurred at the time of theentertainment activity but were not "with respect to" the entertainment facility. The hot air balloon wasfound to be an entertainment facility.

27 See McReavy v. Commissioner, 57 T.C.M. (CCH) 133 (1989) (court disallowed all expensesexcept interest and property taxes); see also I.R.C. § 274(0; Dodd, 63 T.C.M. (CCH) 3141.

I.R.C. § 274(g).29 See W.L. Schautz Co. v. United States, 567 F.2d 373, 375 (Ct. Cl. 1977).30 Treas. Reg. § 1.274 (as amended in 1985).

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or loss" on sale in the same manner as other property held partly for business andpartly for personal purposes. 31

One of the dangers of disallowance under § 274 is that the disallowedexpenditures may be treated as constructive dividends to the shareholders of thecorporation. "Any expenditure made by a corporation for the personal benefit of itsstockholders, or making corporate-owned facilities available to shareholders fortheir personal benefit, may result in the receipt by the shareholders of constructivedividends." 3 The standard for determining the amount of a constructive dividendwhere the corporation has title to the property is the fair rental value of theproperty.33

ARE THERE ANY APPLICABLE EXCEPTIONS To THE RULE?

Recreational Expenses For Employees

I.R.C. § 274(e)(4) provides that the disallowance provisions of subsection(a) shall not apply to "Expenses for recreational, social, or similar activities(including facilities therefor) primarily for the benefit of employees (other thanemployees who are highly compensated employees within the meaning of §414(q))."34 Generally, this exception applies to the

usual employee benefit programs such as expenses of a taxpayer...in holding Christmas parties, annual picnics, or summer outings, forhis employees generally, or ... of maintaining a swimming pool,baseball diamond, bowling alley, or golf course available to hisemployees generally. Any expenditure for an activity which is madeunder circumstances which discriminate in favor of employees whoare officers, shareholders, or other owners, or highly compensatedemployees shall not be considered made primarily for the benefit ofemployees generally. On the other hand, an expenditure for anactivity will not be considered outside this exception merelybecause, due to the large number of employees involved, the activityis intended to benefit only a limited number of such employees atone time, provided the activity does not discriminate in favor of

31 Id

32 Stan Frisbie, Inc. v. Commissioner, 60 T.C.M. (CCH) 440 (1990) (citing Ashby v. Commissioner,

50 T.C. 409, 417 (1968)).33 Id (citing Nicholls, North, Buse Co. v. Commissioner, 56 T.C. 1225, 1240-41 (1971).14 I.R.C. § 274(e)(4) (1992). I.R.C. § 414(q) states "[tihe term 'highly compensated employee' means

any employee, who during the year or preceding year - (A) was at any time a 5-percent owner, (B)received compensation from the employer in excess of $75,000, (C) received compensation from theemployer in excess of $50,000 and was in the top-paid group of employees for such year, or (D) was atany time an officer and received compensation greater than 50 percent of the amount in effect under §415(b)(1)(A) for such year." I.R.C. § 414(q). The $75,000 and $50,000 amounts are adjusted annually forcosts of inflation. See I.R.C. § 414(q) (1992); I.R.C. § 415(b)(l)(A) (1992); I.R.C. § 415(d) (1992).

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officers, shareholders, other owners, or highly compensatedemployees. 35

The actual use of property is the controlling factor in determining whetherthe § 274(e)(4) exception applies. If the property is never or rarely used byemployees, then the property will not be considered to be held "primarily for thebenefit of employees."3 However, "a reasonable classification of eligibleemployees, whether by time when the recreational facilities may be enjoyed [or] bynature of the work, etc., would appear to be within the provisions of §274(e)[(4)]." 37 For example, the Tax Court has upheld a company policy forproviding cruises to employees that in effect resulted in the exclusion of temporaryemployees of the company. 38 Section 274(e)(4) does not require absolute equalaccess by all employees to recreational facilities but allows flexibility based upon anondiscriminatory, reasonable, and realistic method of selecting participants. 39

The Code, Regulations, and case law do not provide much in the way ofspecific guidance as to what is meant by "primarily for the benefit of." However,in American Business Service Corp. v. Commissioner, the court noted that lessthan half of those who participated in cruises provided by the company wereofficers, stockholders, or highly-compensated employees. The court found theexception applied in that case. 4

0 In McReavy v. Commissioner,41 the court foundthat a lake property was not primarily for the benefit of employees because the useby employees other than the shareholders was minor and employees other thanshareholders were usually accompanied by one of the shareholders when they usedthe facility.42 It can be concluded that more than fifty percent use by employeeswould be sufficient for the exception to apply.

Expenses Treated As Compensation

I.R.C. § 274(e)(2) provides an exception to the disallowance provisions of §274(a) to the extent the taxpayer treats an expenditure for entertainment, or for useof a facility in connection therewith, as compensation to an employee who is arecipient of the entertainment. 4 The expenditure must be treated as compensationto the employee and as "wages to the employee for purposes of withholding." 44

35 Treas. Reg. § 1.274-2(f)(2)(v) (as amended in 1985).36 McReavy v. Commissioner, 57 T.C.M. (CCH) 133, 133 (1989).37 American Business Serv. Corp. v. Commissioner, 93 T.C. 449, 461 (1989).38 Id.39 id.

40 Id at 460.41 57 T.C.M. (CCH) 133 (1989).42 id43 I.R.C. § 274(e)(2) (1992).44 Treas. Reg. § 1.274-2(f)(2)(iii)(b) (as amended in 1985).

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The current Corporation policy relies on this exception to obtain a deductionto the extent of the amount treated as compensation to employees. However, this isa limited exception. Corporation is still unable to deduct depreciation, repairs, andmaintenance. The amount of those deductions is significantly greater than theamount of deduction for compensation to employees.

Entertainment Sold To Customers

Section 274(e)(8) provides an exception for "expenses for goods or services(including the use of facilities) which are sold by the taxpayer in a bona fidetransaction for an adequate and full consideration in money or money's worth.' ' 5Thus, the disallowance provisions would not apply to the condos if fair rental valuewere charged to all customers and all employees were charged with compensation.

Expenses Includible In Income Of Persons Who Are Not Employees

I.R.C. § 274(e)(9) provides an exception to the disallowance provisions of §274(a) "to the extent that the expenses are includible in the gross income of arecipient of the entertainment .. . who is not an employee of the taxpayer ascompensation for services rendered or as a prize or award under Section 74."46

EXCEPTIONS APPLIED TO TUMMYACHE

The actual use of Tummyache is about sixty percent by customers and fortypercent by employees. The usage percentages indicate that the § 274(e)(2)exception may not be a viable solution for Corporation unless a significant changeis made to the policies concerning usage of the two condos. Section 274(e)(2)provides an exception to the extent expenditures are treated as compensation toemployees. 47 The more significant deductions for depreciation, maintenance, andrepairs are still not available.

Section 274(e)(9) also does not help Corporation. That section requires that anon-employee using the facility does so for services rendered or as a prize oraward.4

Section 274(e)(8) provides an exception to the disallowance provisions if theuse of the facilities is provided in a bona fide transaction for full consideration. 19With respect to Tummyache, Corporation would be able to use this exception if allcustomers using the condominium are required to pay fair rental value and allemployees are charged with compensation. This exception is the most likely

45 I.R.C. § 274(e)(8) (1992).4 I.R.C. § 274(e)(9) (1992).47 I.R.C. § 274(e)(2) (1992).48 I.R.C. § 274(e)(9) (1992).49 I.R.C. § 274(e)(8) (1992).

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argument for deductibility of expenses in connection with Four Clovers. This isdiscussed in the next section.

Section 274(e)(4) provides an exception for recreational expenses "primarilyfor the benefit of employees." 50 If Corporation changed the policy concerning useof the condo, then Corporation could probably rely on the § 274(e)(4) exception todeduct all expenses with respect to Tummyache without having to chargecustomers fair rental value. The exception would not work for Four Cloversbecause the actual use is by a shareholder only.

The problem with the applicability of § 274(e)(4) is that the current actualusage of the condos is about sixty percent by customers and forty percent byemployees. For the § 274(e)(4) exception to apply, the employee use should bemore than fifty percent of the total use. Corporation would have to implement apolicy whereby the usage percentages would change to favor employees other thanthose in the "restricted class"- shareholders, officers, and highly-compensatedemployees. 51

If Corporation wants to rely on the § 274(e)(4) exception with respect toTummyache, then permitting customers to use the condo should be limited. The §274(a) disallowance is aimed at limiting the deductibility of entertainment forindividuals in the restricted class and entertainment of customers by thoseindividuals. Use by customers would weigh against a finding that the facility isprimarily for the benefit of employees. Use by unrelated individuals should also belimited. Use by individuals other than employees would weigh against a findingthat the facility is primarily for the benefit of employees.

The value of personal use of the condominiums would be a taxable fringebenefit to the employee. 2 That means that the value of the personal use must betreated as compensation to the employee and as wages for purposes ofwithholding.53

Substantiation of the actual use of the condominiums will be required. - Alog should be kept showing the use of each condominium. The log should indicatethe dates of any use of the facility, the purpose of the use, and the relationship ofthe person using the facility to the owner of the facility (Corporation). The form ofthe records should be a diary, log, or other systematic format.55

50 I.R.C. § 274(e)(4) (1992).51 Id52 I.R.C. § 61(a)(1) (1992); Treas. Reg. § 1.61-21(a)(1) (1989). Fringe benefits are income subject to

withholding unless excluded under § 132. Id None of the § 132 exceptions applies here. See I.R.C. § 132(1992).

5' I.R.C. § 3402(a) (1992).54 I.R.C. § 274(d) (1992).55 Treas. Reg. § 1.274-5(c) (as amended in 1985).

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A proposed policy for the Tummyache condo aimed at qualifying for the §274(e)(4) exception for recreational use by employees is as follows:

PROPOSED POLICY FOR USE OF THE TUMMYACHECONDOMINIUM (SO AS TO QUALIFY FOR THE § 274(e)(4)EXCEPTION TO THE DISALLOWANCE RULES).

Tummyache is to be held out primarily for the benefit of all ofthe employees of Corporation. In general, all employees are eligibleto use the condominium for recreation. The actual usage of thecondominium shall not discriminate in favor of officers, directors,shareholders, or highly-compensated employees.

Employees desiring to use the condominium shall submit awritten request. Available usage dates shall be allocated on a first-come, first-served basis. An employee who is an officer, director,shareholder, or other highly-compensated employee shall not beable to preempt usage by another employee for a particular date.

The condominium may be made available to customers orprospective customers. However, such availability shall be limited.Total use by employees other than officers, directors, shareholders,or highly-compensated employees shall account for at least 51% ofall use.

A record shall be kept with respect to the use of thecondominium. The record shall indicate who used the facility, thedates of usage, the nature of usage, and the relationship between theuser and Corporation.

CAN FOUR CLOVERS BET REATED As RENTAL PROPERTY?

Four Clovers As An Entertainment Facility

Even if Four Clovers is treated as rental property, deductions with respect tothe condo may be disallowed by operation of § 274. Section 274 operates todisallow expenses in connection with an entertainment facility regardless ofwhether the expense would otherwise be allowed. 56 The condo may be a legitimatebusiness rental property but expenses in connection with the condo will bedisallowed under § 274 if the condo is an entertainment facility and no exception

56 I.R.C. § 274(a)(1)(B) (1992).

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applies.57 This is true even if the expenses are otherwise deductible under § 162.To be deductible, an expenditure must satisfy the tests of both § 162 and § 274.58

The key to determining whether Four Clovers can be excluded from thedefinition of "entertainment facility" is the term "entertainment." Regulation §1.274-2(b) defines "entertainment." "The term 'entertainment' means any activitywhich is of a type generally considered to constitute entertainment, amusement, orrecreation." 9 The regulation notes that an activity may be entertainment even if theactivity relates solely to the taxpayer or the taxpayer's family.(0 The term "mayinclude an activity, the cost of which is claimed as a business expense by thetaxpayer, which satisfies the personal, living, or family needs of any individual,such as providing food and beverages, a hotel suite, or an automobile to a businesscustomer or his family. " 61 The term "does not include activities which, althoughsatisfying personal, living, or family needs of an individual, are clearly notregarded as constituting entertainment." 6 The examples given in the regulationshow that the activities referred to that are not clearly entertainment are clearlybusiness related. 6 The regulation notes that providing a hotel room to an employeewhile in business travel status would not be entertainment while providing a hotelroom to an employee on vacation would be entertainment. 64

Four Clovers is used by Emma as a winter vacation home. Because thecondo is a vacation home, is used for Emma's personal needs and has no clearbusiness purpose, the condo falls within the "entertainment facility" definition.Treatment of the condo as rental property does not prevent the operation of thedisallowance provisions of § 274. 6 It is thus necessary to find an exception to thedisallowance provisions.

57 Robert Zbacnik & Jim Ellerhorst, supra note 17, at 852.

58 Cf Treas. Reg. § 1.212-1 (as amended in 1975). Section 212 applies to individuals. The section

provides that individuals may deduct expenses for the production of income. See I.R.C. § 212 (1992).Treas. Reg. § 1.212-1(h) (as amended in 1975) provides for the deduction of ordinary and necessaryexpenses paid or incurred in connection with the management, conservation, or maintenance of realproperty held by the taxpayer as rental property. Treas. Reg. § 1.212-1(e) (as amended in 1975) notes thatif an expense is disallowed by another Code section, then the expense cannot be deducted even thoughthe expense is paid or incurred for a purpose identified in § 212. Thus, deductions with respect to rentalproperty must meet the tests of § 212 and § 274. The § 274 rules governing deductions for such expensesare the same for business and non-business expenses.59Treas. Reg. § 1.274-2(b)(1)(i) (as amended in 1985).

60 Id61 id62 Id. The regulation gives as examples: "(a) supper money provided by an employer to his

employee working overtime, (b) a hotel room maintained by an employer for lodging of his employeeswhile in business travel status, or (c) an automobile used in the active conduct of trade or business eventhough used for routine personal purposes such as commuting to and from work." d. (emphasis added).63 ld

64 Treas. Reg. § 1.274-2(b)(I)(i) (as amended in 1985).

65 Treas. Reg. § 1.274-2(b)(2)(ii) (as amended in 1985) notes that any reference to "trade or

business" in § 274 includes any rental activity described in § 212.

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Applicable Exceptions

Section 274(e) provides exceptions to the disallowance provisions of §274(a).66 The best exception to rely on with respect to Four Clovers is § 274(e)(8),which provides an exception where the use of an entertainment facility is sold "in abona fide transaction for adequate and full consideration." 67 However, the headingof the section--Entertainment sold to customers--and the regulations indicate thatthe use of the entertainment facility must be sold to a "customer." "

The issue with respect to this exception becomes whether Emma is a"customer." The statute and regulations do not provide a definition of "customer"for purposes of this exception. However, the regulations indicate that "the cost ofproducing night club entertainment.., for sale to customers" would come withinthis exception.69

Emma can probably be considered a customer in the sense that she is atenant of a corporate-owned rental property. Thus, arguably, Four Clovers fallswithin the § 274(e)(8) exception to the disallowance rules. 70

It is unclear whether the § 274(e)(8) exception is a limited one. Theregulations use the language "to the extent the entertainment is sold." 7' However,the "to the extent" language does not appear in the statutory language. 72Considering the examples provided in the regulations as falling within thisexception (operating a pleasure cruise ship and producing night clubentertainment), a limited exception does not make sense. It can be concluded that ifa facility comes within the § 274(e)(8) exception, then all expenses in connectionwith the facility can be deducted. 73

66 Treas. Reg. § 1.274-2(b) (as amended in 1985).67 I.R.C. § 274(e)(8) (1992).68 See Treas. Reg. § 1.274-2(f)(2)(ix) (as amended in 1985).69 Id70 Section 274(e)(7) provides an exception for the use of facilities made available to the public. The

exception does not apply to the Florida condo as Emma has year-round custody of the condo despite thefact she uses the condo for only part of the year. The condo is not held out to the public for the periodsduring which Emma does not occupy the condo.

7 Treas. Reg. § 1.274-2(f)(2)(ix) (as amended in 1985).72 See I.R.C. § 274(e)(8) (1992).73 Arguments that the Florida condo is legitimate rental property would be strengthened by having

Emma pay year-round rent.

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Other Concerns

1. Section 280A

Section 280A disallows certain expenses in connection with rental ofvacation homes if such homes are used during a tax year for personal purposes. 74

The statute applies only to individuals and S-corporations. 5 However, courts haveapplied the statute by analogy to corporate-owned rental property. 76 Thus, thesection should be considered when planning treatment of Four Clovers.

The key to the limitations under § 280A is the taxpayer's personal use of theproperty.77 If a unit is used solely as rental property and not used for personalpurposes as a residence, then the rules under § 280A do not apply. Personal useincludes use by any person who has an interest in the unit. 78 This would likelyinclude a shareholder of a corporate taxpayer. 79

An exception to the "personal use" definition is provided in § 280A(d)(3). Ifa unit is rented to an "individual with an interest," then such use is not consideredpersonal use if the rental is for a fair market rental and the rental unit is used as a"principal residence" by the individual living in the rental unit."' A principalresidence is usually the home an individual lives in. If an individual has more thanone home, then a facts and circumstances standard is applied to determine whichhome is the principal residence. "

If Emma's use is personal use for purposes of this section, then all expensesin connection with the condo would be disallowed because there would be norental use of the unit. 2 Emma's use of Four Clovers would probably beconsidered personal use because application of the facts and circumstances testwould probably result in a determination that Four Clovers is not Emma'sprincipal residence.

If this section were applied by analogy to the Corporation ownership of FourClovers, then a disallowance might occur. However, the arguments under § 162and § 274 are probably strong enough that a concern involving § 280A is unlikelyto arise.

74 See I.R.C. § 280A(a) (1992).75 id.76 See Edilberto Bertran v. Commissioner, 43 T.C.M. (CCH) 892 (1982).17 I.R.C. § 280A(d)(1) (1992)78 I.R.C. § 280A(d)(2)(A) (1992).79 See I.R.C. § 267(c) (1992); see also I.R.C. § 280A(f)(2) (1992).80 I.R.C. § 280A(d)(3)(A) (1992).81 See Treas. Reg. § 1.1034-1(c)(3) (as amended in 1979).82 Section 280A does not operate to disallow deductions that are allowable without regard to any

connection with an income-producing activity. If a unit was used for both personal use and rental orbusiness use, then the deductibility of expenses would have to be determined by applying § 280A(d).

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ENTERTAINMENT FAcILITY RuLEs

2. Section 162 and Section 183

Section 183 limits deductions to the extent of income if an activity is notengaged in for profit. 83 Section 183 applies only to individuals and Scorporations. 8' However, courts have found the considerations concerning profitmotive under § 183 instructive when deciding whether an expense is ordinary andnecessary under § 162.85

A taxpayer must engage in an activity with the predominant motive andintention of making a profit. The profit objective must be reasonable.86

Considerations include profit motive, reasonableness of expense, whether theexpense is incurred for a business purpose with intent to obtain a specific benefit,degree of personal use, and whether the business is operated in a businesslikemanner. 1

The concern with respect to Four Clovers is the existence of a profit motive.Emma uses the condo for only part of the year and pays rent for only that period.The condo is not held out for rent during the periods when Emma does not occupythe condo. Even though Emma pays fair market rent, deductions of all expenses inconnection with the condominium will result in a significant loss. This could resultin a question as to the profit motive of Corporation in owning the condominium.

The profit motive is something that could be questioned and result in afailure to meet the ordinary and necessary standard of § 162. Arguments for fulldeductibility could be strengthened by either requiring Emma to pay year-roundfair market rent or holding the condo out for rent to others during the periods thatEmma is not using it.

CONCLUSION

The corporate-owned condominium as a combination business/entertainment site is no longer a simple way to deduct expenses for a corporate-owned condominium. Under the current interpretation of Internal Revenue Code §274, if a facility is used even incidentally for entertainment, then all expenses withrespect to the facility are disallowed. There are exceptions to the disallowanceprovisions. Most of the exceptions relate to use of such facilities for employees orfor business facilities such as hotels. Section 274 accomplishes the mission ofeliminating lavish entertainment at luxurious properties on pre-tax dollars.

83 See Bolton v. Commissioner, 694 F.2d 556 n.14 (9th Cir. 1982).84 I.R.C. § 183(a) (1992).8" See Edilberto R. Bertran v. Commissioner, 43 T.C.M. (CCH) 892 (1982).86 Id See also Treas. Reg. § 1.162-1 (1960).87 See Treas. Reg. § 1. 162-1 (1960); I.R.C. § 183 (1992); Edilberto R. Bertran 43 T.C.M. (CCH) 892.

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